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  • Hewitt Associates

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    Retirement and Savings Plans in China

    David Moo, Hewitt Associates

    July 2009

  • Key theme: Corporate-sponsored retirement and savings plans in Mainland China Title: Retirement and Savings Plans in China Author: David Moo, FSA Senior International Benefits Consultant, Hewitt Associates (Shanghai) David.Moo@Hewitt.com +86 21 2306 6884 Abstract1 Retirees in China have historically relied on their family and their government to sustain them in their old age. Both of these pillars are crumbling to varying extent, and workers are increasingly going to need to rely on other sources of retirement income. Employers are beginning to step in to fill this gap. However, companies are providing retirement or other savings plans in many different ways. This paper will provide a summary of the methods being used (based on different plan designs and investment structures in particular), the efficacy of each, and what changes are needed to improve the situation for companies, their employees, and the society in general.

  • Hewitt Associate In-depth China Pension Report 1

    Introduction

    China has undergone many dramatic changes in the last 100 years. The government leadership has changed from an Emperor to the Nationalists to the Communists, with foreign and civil wars interspersed. Since the Communist takeover in 1949 and the beginning of New China there have been great upheavals and reorganizations of society, from the Great Leap Forward and the Cultural Revolution to Reform and Opening. With all of this dynamism, it can be difficult to take a long-term view of some of the challenges China is currently facing, including in respect of the aging population.

    China, like many countries, is aging rapidly due to a combination of decreasing birth rates (exacerbated in China by the one-child policy) and a longer lifespan. In fact, according to the Population Reference Bureau, Chinas population is aging at one of the fastest rates ever recorded. The United Nations projects that the ratio of workers to retirees will decrease from 9 to 2.5 by 2050. There will be a heavy burden on upcoming generations to support the elderly during retirement and thus it is vital to begin saving for this future soon.

    As in most countries, there are several ways the saving can be done; the World Bank defines this in terms of the 3 pillars of retirement income security: government-provided social security, employer-provided supplemental savings programs, and individual savings. This paper will examine each of these pillars, with a focus on the methods used by employers to address this critical issue.

  • Hewitt Associate In-depth China Pension Report 2

    Social Security Pension Provision in China

    History Chinas first old age pension system was established in 1951 under the State Councils Regulations on Labor Insurance. Since then, Chinas pension system has gone through several stages of reform precipitated by changes in the political, economic, and social environment. The original system was funded by modest employer contributions to local and national pools and provided on a pay-as-you-go basis. During the Cultural Revolution (1966-1976), social insurance became the responsibility of enterprises: each enterprise paid the pensions of its own retirees out of its current revenue. The unified pension pooling system was eliminated, and accumulated pension funds in the national pool were used for other purposes. Supervisory responsibilities were transferred to local labor bureaus.

    Soon after China announced its open-door policy in 1978, the government began to redevelop the social security system, including reintroducing pooling in 1986. However, as a result of government policies like the one-child policy and expensive early retirement incentives designed to provide employment opportunities for young workers, as well as the transition from a planned economy to a market economy, the pension system entered the 1990s and the first decade of the new millennium in crisis. State-owned enterprises (SOEs) have heavy pension obligations at a time when employment in these enterprises is decreasing and the number of pensioners relative to employees is increasing. Many of these SOEs have only recently begun taking responsibility for their profits and losses, and many cannot manage their pension burden. Moreover, the government realized that it cannot afford to bear pension obligations by itself.

    In 1991 the government instituted additional reforms, including calling for individual contributions by all employees and for experiments with individual accounts. It recognized the need for the traditional three-pillar system.

    Throughout the late 1990s, experiments with individual accounts within the social security system, and with various levels of pooling, were undertaken. Many valuable lessons were learned, but there was also much confusion over who had authority over the system and how to unify the disparate programs. Thus, in March 1998, the Ministry of Labour and Social Security (since renamed the Ministry of Human Resources and Social Security, or MOHRSS) was created in order to consolidate the various departments that had been responsible for some aspects of social security and pension policy. However, even with the centralization of authority in the MOHRSS, many departments within MOLSS, as well as the Ministry of Finance and the National Tax Bureau, continue to influence the evolution of the basic pension system.

    The Current Social Security Pension System The current social insurance pension plan in China was established by State Council Document No. 26, issued on July 1, 1997 and updated by Document No. 38 in 2005. The plan is broadly consistent with World Bank recommendations; its goal is to transition the defined benefit, pay-as-you-go system to a three-pillar model, while incorporating all enterprise and self-employed workers in cities and townships.

  • Hewitt Associate In-depth China Pension Report 3

    Pillar I is composed of two parts:

    Social Pooling (Pillar IA): Enterprises, in general, contribute a tax-deductible 20% of their total wage bill (specific contribution rates are determined by the provinces and municipalities; in all cases the wages used to calculate the contributions are subject to a maximum of 300% and minimum of 60% of average wages in the locality); and

    Individual Account (Pillar IB): Employees contribute (before tax) to individual accounts. In general the contribution rate is 8% of wages (again subject to the 300% of average wages maximum) to the individual account. These accounts were designed to be fully funded; in reality many provinces have been using these funds to support Pillar 1A and other, non-pension obligations and the individual accounts are purely notional. These accounts are also credited with interest each year (at a rate announced by the local government). Recent rates have been in the neighbourhood of 4%.

    Eligibility requirements under the current system are age 60 for males (age 55 for certain hazardous industries), age 55 for female cadres, and age 50 for female workers. An employee must have 15 years of contributions.

    The social security pension retirement benefit consists of the following tax-free amounts:

    Benefits from the social pool: The monthly pension is a percentage of the city average salary (CAS), based on the average of the CAS and the employees indexed contribution salary, multiplied by an accrual rate of 1% for each contribution year. The formula is: 1% x (years of contributions up to 30) x ( (CAS at retirement + Index x CAS at retirement) / 2) Index = Average of the following ratio over all years of contribution: (Individual's salary up to 3 x CAS / CAS in that year) This benefit is payable for life, and is defined as a constant percentage of CAS (and thus increases with CAS over time).

    Benefits from the individual account: The individual account balance is converted to a monthly life annuity pension using a life annuity factor determined by the government (see table below). This benefit remains level (it is not indexed for inflation or salaries).

    For individuals retiring with service years prior to the time the social security pension system was established (in the early 1990s), a transitional benefit is provided from the social pool.

    In most cases the city average salary does not necessarily represent actual average salaries paid. These figures are calculated by the local governments based on data provided to them by companies in their area data which is often understated (likely as a tax avoidance measure). As an illustration, in Shanghai the CAS used for Social Security and other purposes is RMB 3,292 (per month), effective 1 April 2009. So, an employee earning over 3 x 3,292 x 12 = RMB 118,512 w